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ANALYSIS  OF  FINANCIAL  STATEMENTS 


ONE  OF  A  SERIES  OP  LECTURES  IN  A  SYSTEMATIC  COUBSI 


RICHARD  P.  WILSON 
HARRY  J.  CARPENTER 

Credit  Department,  National  Bank  of 
Commerce,  New  York 


HU-345 


La  Salle  Extension  University 

-     CKicagfo 


ANALYSIS  OF  FINANCIAL  STATEMENTS 


RICHARD  P.  WILSON 

HARRY  J.  CARPENTER 

Credit  Department,  National  Bank  of 
Commerce,  New  Yorlc 


La  Salle  Extension  University 

-     Chicag^o 

1919 


(9-119) 


Copyright,  1918 
LaSalle  Extension  University 


CONTENTS 

I.    Analysis  of  a  Wholesale  Grocery  Statement 2 

The  Audited  Statement 2 

Classification  of  Accounts 3 

Analysis  of  the  Assets 6 

Cash  6 

Notes  Receivable   7 

Acceptances 8 

Accounts  Receivable  9 

Merchandise 10 

Real  Estate  and  Buildings 12 

Machinery  and  Fixtures 13 

Patents,  Goodwill,  Leases,  Patterns,  etc 13 

Investments  14 

Deferred  Assets  15 

Consignment  Accounts 15 

Analysis  of  the  Liabilities 15 

Notes  Payable   16 

Accounts  Payable 17 

Accrued  Liabilities 18 

Reserves  18 

Bonded  Debt   18 

Capital  Stock 20 

Surplus  and  Undivided  Profits 20 

Net  Worth 20 

Profit  and  Loss  Statement 21 

Contingent  Liability  22 

Insurance 23 

Life  Insurance  on  Members 23 

...  7 

111 


iv  Contents 

II.    Analysis  of  a  Packing  Statement 26 

Notes  and  Accounts  Receivable 26 

Merchandise    27 

Real  Estate,  Buildings,  Machinery,  and  Fixtures ...  27 

Notes  and  Accounts  Payable 27 

Bonded  Debt    30 

Gain  for  the  Year 30 

Conclusion    30 

III.  Analysis  of  a  Jobbing  Statement 30 

Notes  and  Accounts  Receivable 30 

Net  Worth   31 

Special  Capital 31 

Discounted  Receivables    31 

IV,  Analysis  of  a  Cotton  Mill  Statement 32 

Current  Assets 32 

Fixed  Assets 33 

Management 36 

V.     Summary 36 


ANALYSIS  OF  FINANCIAL  STATEMENTS 

Too  much  stress  cannot  be  laid  upon  the  importance 
of  a  proper  analysis  of  the  financial  statement.  The 
statement  is  a  photograph  of  the  business  and,  if  not 
correctly  viewed,  the  whole  complexion  of  the  risk  is 
altered  and  the  possibilities  of  use  defeated. 

The  financial  statement  assumes  an  important  place 
in  modem  management.  Executives,  officers,  and  direct- 
ors of  corporations  should  be  able  to  make  an  actual 
analysis  of  the  financial  statement  of  their  business  if 
they  are  to  plan  constructively  and  wisely.  Investors 
are  able  to  buy  securities  on  a  more  scientific  basis 
when  they  are  able  to  view  the  exact  conditions  and 
contingencies  of  a  business  as  shown  in  its  statements. 
Credit  men  make  daily  use  of  statements.  While  it  is 
time  in  granting  credit,  whether  in  the  form  of  loans 
or  merchandise,  that  the  personal  equation  and  the 
knowledge  of  the  debt-paying  record  of  the  subject  are 
important  features,  the  story  told  by  the  financial  state- 
ment is  the  fundamental  basis  upon  which  credit  is 
granted.  Accountants,  of  course,  are  interested  in  the 
accounting  science  and  the  technique  involved  in  the 
preparation  of  statements,  as  well  as  in  the  use  they 
serve. 

The  exact  purpose  of  the  analysis  differs  somewhat 
with  these  classes.  The  credit  dispenser  is  interested 
pri^iarily    in    deteniiining   the    debt-paying    ability   of 

1 


2  WILSON  AND  CARPENTER 

the  applicant  for  credit  a  short  period  ahead.  The 
executive  and  the  investor  are  likemse  interested  in 
these  factors,  but  they  are  more  vitally  interested  in  a 
growing  earning  power  and  a  consistent  dividend-pay- 
ing ability  over  a  considerable  period  of  time. 

The  principles  of  analysis  are  quite  similar,  whatever 
the  purpose.  Since  by  far  the  most  important  use  of 
financial  statements  is  in  the  granting  of  credit,  this 
treatise  will  explain  the  analysis  of  financial  statements 
chiefly  from  that  point  of  view.  The  principles  and 
methods  of  analysis  will  be  developed  in  connection 
with  an  analysis  of  representative  statements  from  tj^pi- 
cal  classes  of  industries. 

I.    Analysis  of  a  Wholes.u.e  Grocery  Statement 

The  first  type  of  statement  will  be  that  of  a  whole- 
sale grocery  house.  Figure  1  is  the  form  in  which  the 
statement  is  received  from  the  company. 

THE   AUDITED   STATEMENT 

One  of  the  first  points  to  determine  is  whether  the 
statement  is  audited.  The  value  of  an  audited  state- 
ment is-  readily  appreciated  in  that  it  is  the  opinion 
of  a  disinterested  party  of  the  condition  of  a  business, 
as  against  a  compilation  by  the  concern  itself,  which 
concern  would  be  inclined,  without  any  dishonest  inten- 
tion, to  be  liberal  in  its  attitude  as  regards  realization 
on  certain  assets. 

The  next  step  is  to  consider  how  the  accountants  rank 
in  their  profession,  the  value  of  the  audit  being  lost 
should  it  develop  that  the  accountants  are  other  than 
unbiased  parties  or  lack  the  necessaiy  qualifications  of 
their  profession. 


FINANCIAL  STATEMENTS  3 

CLASSIFICATION   OF   ACCOUNTS 

The  initial  step  in  analyzing  statements  is  more  or 
less  a  process  of  elimination.  The  information  from  the 
statement  is  transferred  to  a  **  Comparison  of  State- 
ments" form,  Fii^Tire  2,  and  so  grouped  as  to  bring  out 
more  prominently  certain  leading  features  of  the  finan- 
cial condition  of  the  concern.  The  assets  are  separated" 
into  two  classifications:  (1)  those  of  a  current  or 
debt-paying  character  and  (2)  those  of  a  permanent 
character.  The  latter  assets,  of  course,  could  be 
divided  into  several  other  classifications,  but  their  slow 
liquidating  character  would  not  be  altered;  thus  the 
foregoing  distinction  into  two  classes  will  answer  our 
purpose.  ^ 

The  distinction  between  the  current  liabilities  and 
those  of  a  deferred  nature  is  not  so  marked  as  in  the 
case  of  the  assets ;  deferred  or  long-time  obligations  are 
those  of  a  bonded  indebtedness,  mortgage  or  debenture 
nature  only. 

The  percentage  of  total  current  liabilities  to  total 
quick  assets  is  indicated.  In  this  illustration  it  is  47, 
indicating  that  the  current  liabilities  are  47  per  cent 
of  the  quick  assets. 

Credit  men  ordinarily  look  for  a  2  for  1  condition,  or, 

in  other  words,  $2  of  quick  assets  to  discharge  $1  of 

debt.    Where  the  statement  varies  from  this  condition, 

consideration  should  be  given  to  the  reason  therefor. 

[  The  2  to  1  ratio  of  ' '  quicks ' '  is  not  an  absolute  standard, 

isimply  a  working  rale.    Another  method  of  indicating 

the  percentage,  in  line  with  the  foregoing,  is  through  the 

division  of  the  quick  assets  by  current  liabilities,  which, 

in  the  instance  under  discussion,  results  in  a  percentage 

of  2.14,  or  $2.14  for  every  $1  of  current  debt. 

Let  us  now  take  the  statement,  item  for  item. 


WILSON  AND  CARPENTER 

LAKESIDE  GROCERY  COMPANY 
DETROIT,  MICH. 

Statemext  as  of  December  31,  1916 


Assets 

Cash  $88,225.16 

Notes  Receivable 104,424.22 

Accounts  Receivable   .  .  506,325.36 

Merchandise    812,150.09 

Real  Estate,  Bldgs.,  etc.  328,147.51 
Investment  in  A.  B.  C. 

Can  Co 180,000.00 

Loans  to  Officers,  Em- 
ployees, etc 13,652.62 

Deferred  Assets  7,804.31 

Machinery  &  Fixtures.  92,018.04 

Patents  &  Goodwill . .  .  400,000.00 


Liabilities 

Notes  Payable    $600,000.00 

Accounts  Payable   ....  69,558.32 

Accrued  Interest 1,562.21 

Bonded  Debt    ($10,000. 

Exp.  Annually)    100,000.00 

Reserve  for  Bonus,  etc.  25,162.44 
Capital — 

Preferred     ( 6%     Cu- 
mulative)      700,000.00 

Common  400,000.00 

Surplus    636,464.34 


$2,532,747.31 


$2,532,747.31 


Sales   (1916)— $4,688,293.78 
Profits— $147,983.35 

Dividends — 6%  Preferred — 8%  Common 
Depreciation — $25,762.54 

We  have  examined  the  books  and  accounts  of  the  Lakeside  Grocery 
Company,  of  Detroit,  Mich.,  as  of  December  31,  1916,  for  the  purpose  of 
verifying  the  assets  and  liabilities  and  certifj'ing  that  the  foregoing  state- 
ment is  correctly  prepared  therefrom. 

We  have  satisfied  ourselves  that  the  inventories  of  merchandise,  mate- 
rials, and  supplies,  as  reported  to  us  by  the  management  of  the  company, 
have  been  prepared  on  a  proper  basis  and  that  the  values  placed  on  the 
various  items  are  cost  or  lower  than  cost  to  conform  to  the  fluctuations 
in  the  market  price.    All  ascertained  liabilities  have  been  provided  for. 

We  hereby  certify  that  in  our  opinion  the  foregoing  statement  sets  forth 
the  true  financial  position  of  the  company  as  at  December  31.  1916. 

Smith  Joxes  &  Co.mpaxy 
January  22,  1917  (Chartered  Accountants) 

Detroit,  Mich. 


Fig.  1. — Statement  as  Received  from  the  Wliolesale  Grocery  Company 


FINANCIAL  STATEMENTS 


COMPARISON   OF  STATEMENTS 
fi^KKS  ICR-GaOCER? D9llEait..Micli. »<i.ti<.«j^Tifllflsala.C-roaery - 

Pfirrl.        TliT-P^t 

ASSETS 

J^f^SXA^}^... 

Cash 

9( 

22f 

-16 



— 



_ 

5oe 

32f 

3fi 

— 

— 

— 

Mcrrhindtx.  fiaUhed                1 

tiir 

isn 

ni 

RaiT   Material                                 1 

TOTAL..OUICK  ASSETS 

Sll 

1^4 

m 

Real  Estate                                  ) 

J25 

147 

5] 

Bldst.                                            ) 

Machinery  fit   Fixtures 

92 

PIP 

04 

Patent*  &  Good  Will 

4nn 

nnn 

nn 

Iftfl 

non 

nn 

^^ 

fiS' 

fi? 

Deffirrfld    A^-iPt.*; 

7 

fln4 

ill 

TOTAL 

2 

53Z 

747 

31 

LIABILITIES 
Bills    Payable,    Merchandise 

— 

Dills    Payable   to  own    Banks 

600 

000 

00 

Bills    Payable,   cihcrwise 

Accounts  Payable 

p? 

PM 

,■^2 

1 

Sfi? 

?1 

BtinHpH    rv-ht.    rPttrpmftTil 

10 

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. 

:>K 

ifi? 

~ 

Tom  CcniRinT  LiAaiimti 

7n(i 

?n? 

<>i 

BofKled    Debt    (When    due>1923 

90 

000 

00 

MortRage    Loans    (Wliffo  due) 

Total  Liabilities 

7?fi 

2fl?; 

17 

1    AutI)    Prf  1     6    7.  ihr  Cxir 

Tnn 

nnn 

nn 

^P'-  I    Auth.  Com. 

400 

onn 

nn 

SufDluj    &    Urtdivlded    Profits 

mii 

4£i 

2A 

TOTAL 

1 

532 

747 

31 

rriTAi.   QinrK    a<;<;pt«; 

f.l 

f^ll 

124 

RS 

•■  CURRENT  LIABILITIES 

*> 

•mA 

7a? 

<17 

■ 

' 

EXCESS-OUICK 

804 

841 

S6 

SalM 

4 

fiflfl 

P.l.-l 

7fi 

ConUncent   Liabilities 

Innranrr 

Diyidcnds 

'^ 

^^ 

ii^ 

iiii 

Dcpreciatioa 

/fS 

7f? 

^4 

T4«  Pro6ti 

M7 

Rflrt 

i^fi 

Fig.  2. — Comparison  of  Statements — Lakeside  Grocery  Company 

Note. — In  these  printed  forms  the  terms  "Bills  Receivable"  and  "Bills 
Payable"  are  used  instead  of  the  more  acceptable  accounting  terminology 
of  "Notes  Receivable"  and  "Notes  Payable." 


6  WILSON  AND  CARPENTER 

ANALYSIS   OF    THE   ASSETS 

After  the  information  from  tlie  statement  has  been 
transferred  to  the  ** Comparison  of  Statements"  form, 
and  it  has  been  ascertained  that  the  ratio  of  current 
assets  to  current  liabilities  is  such  as  to  warrant  the 
extension  of  the  credit  applied  for,  then  the  credit  man 
begins  to  analyze  and  compare  the  different  items  of  the 
report.  First  he  considers  the  assets.  He  analyzes 
those  items  of  a  liquid  character  rather  minutely  because 
they  are  of  primary  importance  in  considering  banking 
and  commercial  credit.  Fixed  assets  interest  him  as 
much  on  account  of  the  carrying  charges  which  they 
may  involve  as  on  account  of  their  ultimate,  realizable 
value.  Bonds,  for  example,  involve  a  current  liability 
for  interest  charges. 

CASH 

In  this  particular  statement  the  item  indicates  a  good 
cash  position,  which  is  generally  a  mark  of  a  healthy 
condition.  In  some  cases,  a  nominal  cash  item  is  shown, 
due  to  the  company's  practice  of  using  a  large  portion 
of  its  available  cash  to  retire  outstanding  obligations 
just  prior  to  statement  date. 

Cases  have  been  found  where  a  concern  has  applied 
its  cash  to  the  reduction  of  its  Notes  Payable  without 
an  actual  retirement  of  that  indebtedness;  e.  g.,  a  book- 
keeping transaction  by  which  a  reduction  of  an  equiva- 
lent amount  is  made  in  both  the  Cash  and  the  Notes 
Payable  items.  It  is  scarcely  necessary  to  mention  that 
this  practice  is  not  condoned,  as  the  statement  so  sub- 
mitted does  not  show  the  actual  condition  of  the 
business. 

Most  commercial  banks,  when  making  loans  to  custom- 


FINANCIAL  STATEMENTS  7 

ers,  endeavor  to  have  cash  balances  maintained  with 
them  of  about  20  per  cent  of  the  amount  of  the  loans. 
A  nominal  cash  item,  compared  to  Notes  Payable,  indi- 
cates, therefore,  that  the  banks  of  deposit  are  not  being 
treated  liberally  in  the  way  of  balances.  (We  are,  of 
course,  assuming  that  the  company's  borrowings  are  all 
secured  through  banks  and  not  through  commercial 
paper  brokers;  in  the  latter  case  the  cash  item  could  not 
be  reconciled  to  the  payables.) 

It  is  also  desirable  to  know  whether  there  are  included 
in  the  cash  item  Time  Certificates  of  Deposit,  for,  while 
these  certificates  represent  actual  cash  on  deposit,  they 
may  be  used  as  collateral  against  loans,  which  fact 
would  not  be  shown  on  the  face  of  the  statement.  This 
would  naturally  mean  the  tying  up  of  these  funds  until 
the  maturity  of  the  loans ;  therefore  although  a  case  of 
this  character  is  unusual,  it  should  be  borne  in  mind. 

NOTES   RECEIVABLE 

I  The  most  vital  point  to  be  considered  in  the  analysis 
of  this  item  is  whether  the  figure  shown  represents 
notes  from  customers  only,  obtained  in  the  regular 
course  of  business.  If  included  in  this  amount  are 
notes  due  from  subsidiary  or  affiliated  interests,  officers, 
or  employees,  the  amount  of  such  notes  should  be  with- 
._^rawn  and  placed  in  the  slow  assets. 

In  the  foregoing  statement,  the  Notes  Receivable  item 
is  in  good  proportion  to  the  volume,  but  if,  for  instance, 
these  receivables  should  total,  say,  $300,000,  it  would  be 
an  indication  that  many  of  the  company's  customers 
were  not  of  a  particularly  high  grade;  for  example, 
retail  dealers,  short  of  ready  cash,  who  have  been 
obliged  to  give  notes  in  payment  for  merchandise. 

A  large  Notes  Receivable  item  might  also  reflect  unfa- 


8  WILSON  AND  CARPENTER 

vorable  business  conditions  prevailing  in  the  company's 
locality. 

Even  in  cases  where  a  fairly  good  knowledge  is  had  of 
the  class  of  customers  catered  to,  and  despite  the  fact 
that  the  statement  is  audited  by  reputable  accountants 
and  all  doubtful  accounts  are  eliminated,  a  certain  allow- 
ance must  be  made  for  depreciation  in  this  item,  maybe 
not  in  actual  figures,  although  this  is  done  quite  often — 
to  be  borne  in  mind  when  forming  a  judgment  of  the 
value  of  the  concern's  receivables. 

At  times  we  find  the  item  "Notes  Receivable  Secured 
by  Eeal  Estate,"  or  some  other  collateral.  This 
always  leaves  the  impression  that  the  prompt  collecti- 
bility of  the  item  is  questioned  ;  consequently  should  this 
amount  be  large,  a  word  of  explanation  from  the  cus- 
tomer would  be  in  order. 

In  the  grocery  business,  goods  are  sold  on  30  days,  60 
days,  and  sometimes  four  months,  but  the  last-men- 
tioned tenns  are  the  exception,  the  majority  of  the 
accounts  being  settled  in  at  least  60  days.  In  view  of 
this  comparatively  quick  ''turnover,"  one  seldom  finds 
a  large  Notes  Receivable  item  in  the  statement  of  a 
wide-awake,  aggressively  managed,  wholesale  grocery 
concern.  Of  course,  a  small  Notes  Receivable  item  might 
be  indicative  of  a  practice  by  the  company  of  discount- 
ing its  customers'  notes,  which  would  constitute  a  con- 
tingent liability,  a  point  which  is  covered  in  detail 
further  along  in  the  discussion. 

ACCEPTANCES 

In  instances  where  companies  sell  their  merchandise 
on  an  acceptance  basis,  the  acceptances  would,  of  course, 
be  available  for  discount  with  their  bankers,  or  for  dis- 
posal in  the  open  market.    This  would  obviate  the  neces- 


-V 


FINANCIAL  STATEMENTS  9 

sity  of  borrowing  on  their  own  note  to  the  extent  of 
their  operations  tinder  such  an  arrangement.  The  dis- 
count or  sale  of  such  acceptances  unless  ''without 
recourse"  would  constitute  a  contingent  liability. 

ACCOUNTS   RECEIVABLE 

As  mentioned  above,  groceries  are  usually  sold  by  the 
wholesaler  on  30  or  60-day  terms;  thus  with  Accounts 
Beceivable  of  $506,325.36  and  Notes  Receivable  of  $104,- 
424.22,  a  total  of  $610,749.58,  on  a  volume  of  $4,688,- 
293.78,  it  is  quite  plain  that  in  this  instance  the  accounts 
are  being  carefully  watched,  the  collections  averaging 
approximately  45  days.  This  conclusion  is  reached  by 
dividing  the  total  sales  by  the  total  of  the  Accounts  and 
Notes  Receivable.  The  result  in  this  instance  is  about 
eight  times,  corresponding  to  one  and  a  half  months 
each,  or  45  days. 

A  point  worthy  of  note  in  this  connection  is  whether 
the  accounts  have  been  pledged  in  any  way.  Of  course, 
with  reputable  accountants,  this  fact  would  be  forcibly 
brought  out,  but  otherwise  there  would  be  no  indication 
of  the  assignment  of  accounts.  A  word  of  explanation 
regarding  assigned  accounts  might  not  be  amiss  at  this 
time. 

In  the  banking  world  there  are  private  bankers  whose 
business  is  that  of  assisting  concerns  in  a  rather  weak 
financial  position,  by  making  advances  to  these  con- 
cerns, secured  by  the  regular  open  accounts  on  the 
books.  The  rate  for  this  accommodation  is  always 
higher  than  the  average  discount  rate.  As  the  accounts 
are  settled,  the  proceeds  are  applied  to  the  money 
advanced,  but  in  hypothecating  its  accounts  the  company 
remains  contingently  liable  for  their  ultimate  payment. 

This  method  of  financing  is  not  in  favor  with  credit 


10  WILSON  AND  CARPENTER 

grantors,  the  feeling  being  that  if  a  concern  is  in  a 
sufficiently  good  position  to  cash  its  accounts,  it  should 
be  able  to  effect  a  connection  with  a  bank  from  which 
it  can  obtain  its  requirements  and  thus  effect  a  con- 
siderable saving  of  interest. 

In  connection  with  the  Accounts  Receivable  it  is  also 
well  to  learn  whether  all  doubtful  accounts  have  been 
charged  off  and  whether,  as  in  the  case  of  the  Notes 
Receivable,  these  accounts  are  due  from  customers  for 
merchandise  sold  in  the  usual  course  of  business. 

Indebtedness  due  from  subsidiaries  or  affiliations 
(which  concerns  might  be  operating  as  branches,  in  the 
case  of  distributors,  or  as  producers  in  allied  lines,  in 
the  case  of  manufacturers)  should  not  be  included  in  the 
quick  assets,  because  while  the  receivables  so  due  may 
be  liquidated  from  time  to  time,  they  are  more  or  less 
of  a  permanent  character  (depending  of  course  on  the 
line  of  business)  and  frequently  represent  the  actual 
working  capital  or  investment  in  the  subsidiary.  There- 
fore, in  the  event  of  liquidation,  these  funds  are  not 
usually  found  to  be  of  full  realizable  value. 

Where  branch  houses  are  not  separately  incorporated, 
no  current  or  open  accounts  with  the  main  office  should 
appear  as  an  asset.  The  cash,  receivables,  and  merchan- 
dise and  whatever  indebtedness  the  branch  may  be  per- 
mitted to  incur,  are  merely  a  subdivision  of  the  resources 
and  the  liabilities  of  the  company  as  a  whole  and  should 
assume  their  respective  places  in  the  balance  sheet. 

MERCHANDISE 

This  is  usually  the  most  important  item  in  the  current 
assets  and,  as  a  nile,  constitutes  the  major  portion 
thereof.  It  is  important  to  know  whether  the  inventory 
has  been  careful Ij^  taken.     Inventories  are  frequently 


FINANCIAL  STATEMENTS  11 

taken  and  certified  to  by  the  management,  but  the  super- 
intendence of  the  inventory  checking  by  accountants  is 
desirable. 

If  the  market  price  at  inventory  date  is  above  cost, 
the  goods  should  be  carried  at  cost  figure,  but  if  there 
has  been  a  decline  in  price,  the  merchandise  should  be 
carried  at  the  current  market  value ;  in  the  latter  case, 
it  is  also  well  to  provide  for  further  shrinkage  due  to 
increased  selling  expenses,  etc. 

It  is  important  that  the  merchandise  of  a  more  or  less 
unsalable  character  be  separately  considered  and  that 
a  movable  valuation  be  set  upon  it. 

In  view  of  the  staple  character  of  the  grocery  business, 
a  liberal  charge-off  on  the  merchandise  is  not  so  neces- 
saiy  as  would  be  the  case  with  a  concern  handling  spe- 
cialties, such  as  in  the  electrical  goods,  hardware,  and 
other  lines,  in  which  the  depreciation  may  be  heavy,  due 
to  change  in  style,  etc. 

^  One  of  the  principal  points  to  be  borne  in  mind  is  how 
(rapidly  the  merchandise  is  being  turned  over.  By  com- 
parison with  the  volume  of  business  it  will  be  noted  that 
the  merchandise  of  the  concern  under  discussion,  taking 
the  amount  as  fairly  representative  of  the  average 
amount  of  stock  carried  through  the  year,  has  been 
turned  over  something  like  six  times,  which  indicates  an 
efficient  management.  The  credit  examiner  should  be 
familiar  with  the  customary  turnover  in  the  line  of 
business  represented  by  the  concern  whose  statement 
is  under  consideration. 

^^  The  success  of  any  business  hinges  largely  on  two 
points:  (1)  the  ability  to  turn  the  merchandise  rapidly 
at  a  profit  and  (2)  the  prompt  collection  of  accounts. 

In  the  event  that  an  abnormal  amount  of  merchandise 
in  proportion  to  the  business  is  shown,  it  is  well  to  learn 
the  reason,  and  if  possible  the  credit  grantor  should 


12  WILSON  AND  CARPENTER 

make  inquiry  regarding  the  prevailing  conditions  in  the 
particular  line  of  business  in  which  engaged.  In  some 
cases  an  unusually  large  inventory  is  necessaiy,  due  to 
the  company's  distance  from  its  sources  of  supply.  Sea- 
sonal conditions  may  at  times  affect  the  inventories. 
In  other  words,  the  credit  grantor  must  determine  for 
himself  whether  the  conditions  existing  warrant  the 
carrying  of  an  unusual  supply  of  merchandise. 

EEAL   ESTATE   AND   BUILDINGS 

The  first  point  to  be  covered  is  ownership.  Is  the 
property  owned  by  the  company  in  fee  simple,  or  does 
the  title  rest  with  a  realty  holding  company,  individuals, 
or  others? 

Of  what  construction  are  the  buildings?  Is  a  sprink- 
ler system  installed?  Is  everything  properly  insured? 
Last  and  most  important,  has  a  proper  depreciation 
charge  been  made  each  year?  It  is  very  important, 
despite  careful  upkeep  and  replacements,  to  make  rea- 
sonable depreciation  charges.  The  repairs  and  replace- 
ments made  during  the  year  should  be  charged  direct  to 
Operating  Expense;  new  additions  and  betterments, 
however,  constitute  a  charge  to  Plant  Investment. 

If  a  steady  increase  in  Plant  Investment  is  reflected 
from  year  to  year,  it  would  be  well  to  know  the  com- 
pany's policy  in  this  direction.  Commercial  banks  do 
not  condone  the  policy  of  the  borrowing  of  money  by 
concerns  to  invest  in  fixed  assets;  it  is  their  feeling 
that  new  additions,  etc.,  should  be  financed  either  out 
of  the  earnings  of  the  company  or  through  increased 
capital  investment. 

In  prosperous  times  there  is  a  strong  temptation  to 
spread  out  and  make  substantial  additions  to  plants. 
It  is  here  that  the  banker  should  step  in  and  sound  a 


FINANCIAL  STATEMENTS  13 

note  of  warning,  for,  while  it  may  be  true  that  condi- 
tions at  the  moment  warrant  the  plant  enlargements 
contemplated,  serious  thought  must  be  given  to  whether 
the  business  is  likely  to  continue  increasing  or  whether 
the  increased  demand  is  due  only  to  temporaiy  con- 
ditions. 

Sometimes  statements  show  only  a  ''Real  Estate 
Equity";  that  is,  the  value  of  the  property,  less  mort- 
gage. This  is  a  poor  way  of  showing  real  estate  invest- 
ment, as  it  is  essential  for  the  credit  grantor  to  know 
the  amount  and  maturity  of  the  mortgage  and  the  fixed 
interest  charges.  Where  an  increase  in  the  Real  Estate 
item  is  shown,  it  should  be  learned  whether  this  increase 
is  due  to  additions  or  improvements  or  to  a  revaluation. 

MACHINERY  AND   FIXTURES 

What  has  been  said  in  the  foregoing  as  regards  depre- 
ciation of  buildings,  holds  good  with  equal  force  in  this 
instance.  Machinery  is  subject  to  constant  wear  and 
tear,  and  in  these  days  of  modem  invention,  machinery 
is  often  made  obsolete  over  night.  The  age  of  the  equip- 
ment should  be  learned  and  also  whether  it  is  kept  up- 
to-date. 

In  some  lines  of  business,  as  in  the  case  of  cotton  mills, 
printing  concerns,  etc.,  it  is  not  unusual  to  find  that  the 
machinery  has  been  purchased  on  an  instalment  basis, 
a  chattel  mortgage  being  given  the  machinery  manu- 
facturers pending  payment. 

» 

PATENTS,   GOODWILL,   LEASES,   PATTERNS,   ETC. 

Goodwill  is  of  intangible  value  and  usually  covers  the 
so-called  "water"  in  the  capitalization.  It  sometimes 
represents  the  value  at  which  the  company  holds  the 
name  it  has  established  in  the  business  world.    While  in 


14  WILSON  AND  CARPENTER 

many  cases  the  concern  is  justified  in  carr^dng  such  an 
item,  for  the  purpose  of  the  credit  grantor  it  has  no 
particuhir  value  and  should  be  eliminated  from  con- 
sideration when  judging  a  risk. 

In  the  case  of  patterns,  leases,  formulas,  etc.,  these, 
to  a  going  concern,  are  often  of  inestimable  worth,  but 
in  the  event  of  liquidation  their  value  is  always  more  or 
less  problematical. 

INVESTMENTS 

The  investment  item  in  the  statement  should  be  care- 
fully gone  into,  and  where  a  large  amount  appears,  a 
schedule  of  the  investments  is  valuable.  If  composed  of 
government  or  municipal  issues,  or  listed  stock  exchange 
securities,  taken  at  proper  valuations,  the  item  can  be 
considered  as  a  current  asset  because  of  its  liquid  char- 
acter. Investigation  should  extend  to  determining 
whether  any  are  pledged  as  collateral  to  loans  or 
otherwise. 

If  the  item  represents  the  subject's  investment  in 
affiliated  concerns,  it  should  be  classified  with  the  slow 
assets  and  consideration  should  be  given  to  the  com- 
pany's commitments  in  that  direction;  i.e.,  whether 
it  finances  these  concerns  by  advances  of  cash  or  mer- 
chandise, by  indorsement  or  guarantees,  etc.,  and  the 
extent  of  such  operations. 

In  the  case  under  discussion,  the  item  represents  an 
investment  in  only  one  concern,  that  of  a  canning  com- 
pany. The  company  proved  to  be  a  successful  one, 
netting  the  "parent"  company  a  substantial  return  on 
its  investment,  and  at  the  same  time  enabling  it  to  con- 
trol a  source  of  supply. 

Where  a  manufacturing  or  distributing  company 
controls   several   affiliations,   through  stock   o'WTiership, 


FINANCIAL  STATEMENTS  15 

and  is  interested  in  their  financial  arrangements,  a  con- 
solidated balance  sheet  is  most  essential  to  establish 
properly  the  status  of  the  risk. 

UEFEREED   ASSETS 

Under  this  classification  are  included  such  items  as 
Advances  to  Salesmen,  for  traveling  expenses,  etc.,  Pre- 
paid Interest,  Taxes,  Insurance  Premiums,  etc.,  covering 
the  succeeding  period's  operations,  and  which  should  not      ty  i 
be  included  in.ihe  current  assets.    They  are  only  nomi-      '  ^  ' 
nal  assets  and  usually  have  no  realizable  value. 

CONSIGNMENT   ACCOUNTS 

It  is  important  to  ascertain  whether  there  are  any 
consignment  accounts  included  in  the  Accounts  Receiva- 
ble or  in  the  inventory  item,  for  it  can  be  readily  appre- 
ciated that  merchandise  out  on  consignment  is  not  prop- 
erly an  accounL  receivable  until  the  merchandise  is  sold 
and  deliveredH^  Further,  the  merchandise  so  consigned 
not  being  under  the  direct  control  of  the  company  at  all 
times,  is  subject  to  incidental  hazards,  and,  therefore, 
should  be  carried  under  a  separate  classification  so  that 
the  amount  can  be  taken  into  consideration. 

Incidentally  it  might  be  well  to  mention  that  a  com- 
mon rule  to  follow  when  in  doubt  as  to  the  liquid  char- 
acter of  an  asset,  is  to  take  the  item  under  discussion 
and  ask  yourself,  ^' Could  this  be  turned  into  cash 
readily  in  the  event  of  liquidation?" 

ANALYSIS    OF    THE    LIABILITIES 

After  the  asset  side  of  the  statement  has  been  sub- 
jected to  a  sufiicient  analysis,  the  same  process  is  applied 
to  the  liabilities. 


16  WILSON  AND  CARPENTER 

NOTES   PAYABLE 

The  first  thing  to  look  for  in  this  instance  is  whether 
the  Notes  Payable  are  secured  in  any  manner,  that  is, 
through  indorsement,  collateral,  etc. 

There  is  no  fixed  rule  as  to  the  proportion  of  debt  the 
average  concern  should  show  as  compared  with  its  capi- 
tal investment,  and  while  one  naturally  likes  to  see  the 
Notes  Payable  not  greatly  in  excess  of  the  capital,  there 
are  so  many  circumstances  affecting  this  that  it  cannot 
be  reduced  to  any  fixed  ratio.  In  the  foregoing  state- 
ment the  indebtedness  of  the  company  is  in  good  propor- 
tion. We  shall  assume  that  the  Notes  Payable  in  this 
instance,  represent  the  company's  notes  discounted  at 
its  various  banks,  but  in  the  event  that  the  amount 
should  read  $411,692.97,  it  would  be  a  warning  to  the 
analyst  that  the  concern  might  be  giving  notes  for  its 
merchandise,  and  this  is  usually  an  indication  of  lack  of 
working  capital  and  the  best  evidence  to  a  bank  that 
the  funds  advanced  are  not  being  properly  used. 

Sometimes,  however,  this  odd  amount  is  explained 
by  the  fact  that  the  company  has  accepted  deposits  of 
money  from  directors  or  friends,  and  evidenced  by  notes, 
the  odd  amount  representing  the  interest  which  has 
accumulated  on  the  funds  so  deposited. 

In  connection  with  deposits  of  money  by  stockholders 
or  interested  parties,  it  is  well  to  determine  how  the 
amount  was  arrived  at,  i.e.,  whether  through  dividends 
not  withdrawn  or  through  money  loaned  for  the  needs 
of  the  business.  When  of  large  amounts,  it  is  quite 
apparent  how  much  better  it  would  be  to  have  this 
money  fixed  in  the  business  through  the  issue  of  capital 
stock,  for  even  though  it  is  in  friendly  hands,  in  the 
event  of  trouble  this  money  is  usually  the  first  to  be 
drawn  out. 


FINANCIAL  STATEMENTS  17 

If  proper  evidence  is  submitted  that  tlie  indebtedness 
to  stockholders  or  directors  has  been  definitely  subor- 
dinated to  the  general  creditors  and  is  fixed  in  the  busi- 
ness for  a  specific  period  and  the  indorsement  or  guar- 
anty of  such  stockholders  or  directors  offered  or 
obtained,  then  one  would  be  safe  in  considering  the  item 
a  slow  liability. 

A  further  explanation  of  the  odd  amount  of  the  Notes 
Payable  item  might  be  the  fact  that  some  companies 
deduct  the  unearned  interest  charge  on  their  Notes 
Payable. 

Still  another  reason  for  the  odd  amount  in  the  Notes 
Payable  item  might  be  that  the  company  has  included 
its  commitments  through  the  acceptance  by  its  bank 
for  its  account  of  drafts  drawn  under  ''commercial  let- 
ters of  credit,"  which  the  company  has  had  issued  for 
shippers. 

A  veiy  essential  point  in  connection  with  the  Notes 
Payable  is  to  determine  the  peak  of  the  company's  bor- 
rowings and  at  what  period  this  figure  is  reached.  The 
amount  of  Notes  Payable  may  also  bear  some  relation  to 
commodity  prices,  high  prices  requiring  more  capital, 
and  vice  versa. 

ACCOUNTS    PAYABLE 

This  item  represents  money  owed  for  the  purchase  of 
supplies  and,  comparatively  speaking,  should  never  be 
large.  The  average  company  borrows  money  from  its 
bank  to  take  advantage  of  the  cash  discounts  offered 
for  the  payment  of  bills  within  a  specified  period.  A 
large  Accounts  Payable  item  is,  therefore,  a  warning  to 
the  analyst  that  the  company  is  not  availing  itself  of 
these  discounts. 

Accounts  Payable  are  at  times  secured,  and  due  con- 
sideration should  be  given  to  this  feature. 


18  WILSON  AND  CARPENTER 

ACCRUED   LIABILITIES 

This  constitutes  a  current  debt  of  the  company  and 
consists  of  accrued  interest  charges,  taxes,  pay  rolls, 
dividends,  etc. 

RESERVES 

This  item  is  worthy  of  close  attention.  Resei^v^es  set 
aside  for  a  specific  purpose,  such  as  Depreciation  of 
Real  Estate,  Plant,  Machinery,  etc.,  may  be  deducted 
directly  from  the  asset  which  they  affect,  but  this  is  a 
matter  of  opinion,  as  some  analysts  prefer  to  show  these 
reserA^es  under  the  head  of  ''Deferred  Liabilities"  in 
order  that  the  increase  which  should  appear  in  such 
reserves  from  year  to  year  may  be  apparent. 

Reserves  for  Replacements,  Repairs,  or  Improve- 
ments, etc.,  of  course,  should  be  classified  in  the  slow 
liabilities.  Reserves  for  Discounts,  Allowances,  Doubtful 
Accounts,  etc.,  should,  however,  in  all  cases,  be  deducted 
from  the  receivable  items  in  the  assets. 

Reserves  for  Taxes,  Interest,  Bonuses,  Pay  Rolls, 
Dividends,  etc.,  are  not  properly  reserves  at  all,  but  are 
accrued  liabilities  and  as  such  should  be  included  in  the 
current  debt. 

BONDED   DEBT 

This  feature  of  the  statement  should  be  given  very 
careful  thought.  The  first  point  to  detennine  is  when  the 
issue  was  first  brought  out,  then  its  original  amount, 
how  secured,  etc.  In  most  cases,  bond  issues  are  secured 
by  mortgages  on  real  estate,  plant,  etc.  The  actual 
security  back  of  the  issue  should  be  learned,  as  there 
are  many  bond  issues  secured  by  mortgages  covering 
both  real  and  personal  property,  that  is,  real  estate, 


FINANCIAL  STATEMENTS  19 

plant,  merchandise,  accounts,  cash,  etc.,  in  effect  a 
chattel  mortgage  on  the  entire  assets  of  the  company. 
With  a  security  of  this  character  the  bondholders  have 
first  lien  on  all  the  assets  of  the  company  in  the  event 
of  failure. 

The  next  step  is  to  learn  the  date  of  the  maturity  of 
the  issue,  the  rate  of  interest,  and  whether  there  is  a 
specified  annual  retirement  provision.  In  the  case  under 
discussion  we  shall  suppose  that  the  original  bond  issue 
amounted  to  $150,000  and  that  the  bonds  were  brought 
out  in  1911  with  an  annual  retirement  provision  of  $10,- 
000.  At  statement  date,  therefore,  there  was  $100,000  of 
the  bonds  still  outstanding,  and  as  there  is  $10,000 
maturing  during  the  coming  year,  this  amount  should  be 
placed  in  the  current  liabilities. 

There  is  no  set  rule  for  detennining  to  what  extent 
of  the  value  of  the  security  a  bond  issue  may  be  made, 
the  amount  usually  being  determined  by  the  under- 
writers of  the  issue.  It  must  be  remembered,  however, 
that  in  the  event  of  liquidation,  the  fixed  assets  of  any 
concern  undergo  rapid  shrinkage  in  value.  It  is  quite 
natural  to  lose  interest  in  a  proposition  once  your  own 
claim  has  been  settled.  In  the  event  of  a  sale  of  the 
property,  the  bondholders  naturally  are  interested  only 
to  the  extent  of  their  holdings. 

Careful  attention  must  also  be  given  to  the  final  date 
of  maturity,  and  should  such  date  occur  during  the 
current  year,  it  should  be  learned  what  plans  the  com- 
pany has  in  mind  for  the  refunding  of  the  issue,  whether 
by  replacing  the  bonds  through  a  like  issue,  by  issuing 
short-time  notes  or  debentures,  or  by  issuing  additional 
capital  stock.  Sometimes  there  is  a  conversion  clause, 
permitting  the  conversion  of  the  bonds  into  stock  at 
definite  periods.  All  such  questions  should  be  analyzed 
with  a  view  to  the  debt-paying  ability. 


20  WILSON  AND  CARPENTER 

CAPITAL    STOCK 

What  is  the  authorized  issue?  What  is  the  par  value? 
Is  there  any  unissued  stock  in  the  treasury?  Is  the 
treasury  stock  ever  used  as  collateral?  Treasury  stock 
or  treasury  bonds  appearing  in  the  assets  should  be 
deducted  from  the  capital  liability. 

If  there  is  preferred  stock,  what  is  the  rate  of  interest 
on  this  stock?  If  the  dividends  are  cumulative,  are 
there  any  in  arrears? 

If,  in  comparing  the  statement,  the  capital  stock 
shows  an  increase,  the  analyst  should  determine  whether 
this  represents  now  money  paid  in  or  is  the  result  of  a 
stock  dividend  declared  out  of  surplus  and  undivided 
profits. 

Where  there  are  preferred  stock  retirement  pro- 
visions  what  are  the  requirements? 

SURPLUS   AND    UNDIVIDED   PROFITS 

This  should  represent  the  accumulation  of  earnings 
left  in  the  business  from  year  to  year  after  all  disburse- 
ments have  been  made.  This  item,  taken  with  the  capi- 
tal liability,  indicates  the  investment  in  the  business,  and 
it  is  well  to  know  how  it  is  represented  in  the  assets, 
that  is,  how  much  by  quick  assets,  and  how  much  by 
fixed  or  other  assets. 

NET   WORTH 

This  represents,  in  the  case  of  a  copartnership,  the 
partners'  interest  or  investment.  When  the  term  is 
used  in  connection  ^dth  a  corporation,  it  means  the 
paid-in  capital  plus  the  accretion  thereon  (surplus  and 
undivided  profits). 


FINANCIAL  STATEMENTS  21 

PROFIT   AND   LOSS   STATEMENT 

The  Profit  and  Loss  Statement  submitted  by  the 
company  is  shown  in  Figure  3. 

LAKESIDE  GROCERY  COMPANY 

DETROIT,  MICH. 

Profit  and  Loss  Statement 
December  31,   1916 

Sales    $4,688,293.78 

Inventory,  Dec.  31,  1915 $683,741.69 

Purchased  during  1916 4,391,789.57 

$5,075,531.26 
Less— Inventory,  Dec.  31,  1916 812,150.09       4,263,381.17 

Gro&s  Profit  on  Sales $424,912.61 

Selling    Expenses     $82,476.26 

Administration    Expenses    114,372.94 

Miscellaneous    24,835.26  221,684.46 

$203,228.15 
Deduct: 

Depreciation  on  Plant $24,563.49 

Bad  Debts  written  off 1,199.05  25,762.54 

Operating  Profits   $177,465.61 

Deduct  from  Operating  Profits: 

Interest  on  Borrowed  Money $23,482.26 

Interest  on  Bonded  Debt 6,000.00  29,482.26 

Net  Profits  $147,983.35 

Dividend  Payments— $74,000 

Fig.  3. — Profit  and  Loss  Statement 

It  is  desirable  and  very  valuable  to  have  a  statement 
of  the  Profit  and  Loss  Account  supplementing  the  bal- 
ance sheet  for,  while  the  balance  sheet  reflects  the  finan- 
cial condition  of  the  company  at  a  single  period  of  time, 


22  WILSON  AND  CARPENTER 

the  Profit  and  Loss  Account  shows  how  it  arrived  at 
that  condition  from  that  of  a  previous  period.  The 
Profit  and  Loss  Statement  also  reflects  the  earning 
power  of  the  business  and,  after  all,  this  is  a  most 
important  fact  to  know  and  one  from  which  can  be  deter- 
mined w^hether  the  company  will  be  able  to  carry  out  its 
contracts. 

The  Profit  and  Loss  Statement  can  be  compared  with 
those  of  previous  periods  and  the  trend  of  operating 
expenses  in  relation  to  sales  noted,  the  various  features 
of  which  can  be  elaborated  upon  in  line  with  the  business 
under  consideration.  For  instance,  the  interest  paid 
on  borrow^ed  money  may  be  used  as  a  check  on  the  Notes 
Payable  item,  which  might  tend  to  disclose  a  concealed 
debt  in  this  direction.  The  percentage  of  gross  and  net 
profits  to  sales  may  be  determined,  which,  of  course, 
would  fluctuate  largely  in  the  many  different  lines  of 
business  pursuits. 

CONTINGENT   LIABILITY 

The  most  common  form  of  contingent  liability  that 
is  encountered  is  that  brought  about  through  the  prac- 
tice of  indorsing  and  discounting  notes  receivable,  which 
feature  has  already  been  discussed  under  **  Notes 
Receivable." 

Other  forms  of  contingent  liability  may  be  found  in 
connection  with  the  financing  of  subsidiary  companies 
through  the  indorsement  of  current  borrowings,  the 
guaranty  of  merchandise  obligations,  the  guaranty  of 
their  funded  debt,  etc.  A  contingent  liability  sometimes 
arises  in  connection  with  leases  and  contracts  and  in 
other  directions  peculiar  to  some  lines  of  business,  the 
existence  of  which  may  be  recognized  when  met.  Law- 
suits outstanding  and  unsettled  claims  for  damages  or 


FINANCIAL  STATEMENTS  23 

personal  injury  not  covered  by  insurance  also  fall  in 
the  contingent  class. 

Then  there  is  a  contingent  liability  brought  about 
through  the  discounting  or  the  sale  of  acceptances; 
also  through  the  discounting  of  foreign  bills  of  exchange. 

INSURANCE 

This  is  a  very  important  feature  to  the  credit  grantor 
•and  one  which  is  very  often  overlooked.  The  features  to 
be  covered  are  whether  the  merchandise  is  adequately 
protected  and  whether  a  reasonable  amount  of  insurance 
is  carried  on  the  plant. 

LIFE   INSURANCE   ON    MEMBERS 

It  is  becoming  more  and  more  prevalent  among  pro- 
gressive business  houses  to  insure  the  lives  of  the  prin- 
cipal executives.  To  insure  the  life  of  the  producing 
member,  or  members,  of  a  prosperous  business  would 
seem  to  be  sound  judgment,  as  the  producing  genius  of 
a  growing  concern  is  really  one  of  its  most  valuable 
assets. 

Frequently  the  death  of  a  member  of  a  firm  causes 
embarrassment,  and  life  insurance  might  go  a  long 
way  toward  paying  out  the  interest  of  the  deceased  and 
relieving  the  firm  of  a  possible  capital  stringency. 
Further,  a  life  policy  acquires  a  cash  surrender  value, 
which,  in  the  event  of  difficulty  or  liquidation,  would  be 
available  to  the  creditors.  In  the  statement  of  a  going 
concern,  where  ''Cash  Surrender  Value"  appears  as  an 
asset,  the  item  should  be  included  among  the  investments 
and  not  as  a  quick  asset.  Life  insurance  could  also  be 
utilized  in  the  nature  of  a  sinking  fund  taken  out  against 
the  ultimate  payment  of  mortgage  indebtedness. 


24  WILSON  AND  CARPENTER 


ALL-AMERICAN  PACKING  COMPANY 

CHICAC40,  ILL. 
January  1,  191 

A  suet s 

Cash    $902,368.72 

Notes  &  Accounts  Receivable 2,422,476.83 

Merchandise    4,560,322.71 

Real  Estate,  Buildings,  etc 2,934,376.82 

Investments   630,750.00 

$11,450,295.08 

Liabilities 

Notes   Payable    $4,320,624.72 

Bonded  Debt  1,000,000.00 

Capital — 

Common   4.500,000.00 

Surplus     1,629,070.36 

$11,450,295.08 

Dividends — 7% 

Fig.  4. — Statement  of  a  Packing  Concern 


FINANCIAL  STATEMENTS 


25 


COMPARISON  or  STATBMBNttf 

.    1 

Rend.Mraqt 

Reed.Dlreot 

ASSETS                   ,„„     ,     ,„ 

ft 

Jnn.     1        1017 

1 

Cash 

947 

547 

^65 

sn? 

J£fl 

72 

1 

Bills  Receirsble,  Customers           R| 

Accounts    RecciTable,    CuttomerB 

?. 

04.1 

Of^P 

iV 

P 

4'P 

17^1 

n.1 

Merchandise,  finished 

,1 

77n 

IPn 

?■! 

4 

STin 

rip? 

71 

Merchandise,  unfiniEhcd 

Raw  Material 

1 

TOfAt  iiX^lCK  A^sfeYS 

6 

7fil 

403 

03 

.^ 

Rftn 

1An 

26 

* 

Kcal   h*Ut« 

' 

■    B!<Jg»: 

?, 

fiSfi 

fifi:? 

4.1 

0 

^■'4 

.•^7fi 

fl2 

Machinerjr  &  Piaturcs 

■ 

I'atenti  &  Good  Will 

VlU 

non 

on 

fiin 

7fin 

fin 

TOTAL 

9 

^ 

966 

H. 

u 

i^ 

224 

£a 

LIABIHTIE^ 

~ 



^ 

BilU    Payable.    MerchaodlM 

' 

"" 

B)Ub  Payable  lo  owd  Banks 

diU5  Payable,   otherwise 

P 

tfi7 

(197 

4fi         d 

i?n 

fi?4 

7? 

Accounts  Payable 

Chi:itel  Mortgages,  etc 

TotU  CutiiNT  iiAitunii 

p 

C|fi7 

n=(7 

tfi 

. 

ii'yp, 

R?.4 

7? 

Bonded    Debt  ^JV hen   ^ae)  1929 

1 

Qfin 

nfp 

TO 

J^ 

opri 

nno 

00 

Mortgage   Leans   (When   doe) 

— 

Total  Liabilities 

? 

?S7 

3J7 

!« 

."i 

3Zp 

f^?,4 

23. 

. 

(  .Autb.  Pref.          %  Iss. 

'■ 

^P'-  <    Aulh.  Com.  . 

4 

Win 

■)()n 

)0        4 

Fno 

opo 

00 

Surplus  &   Undivided   Profits 

.1 

BOO 

3Afl 

)C      .1 

623 

f,7n 

.1&. 

TOTAL 

6 

957 
761 

!6S 

+50 

2J5, 

OfJ. 

TOTAL    OlJirK    ASSF.T^filJ 

8R5 

Ififl 

26 

"  CURRENT  LIABILITIES 

? 

r^S7 

lt)T 

\f\ 

A, 

•^f>n 

£24: 

■rl 

EXCESS-QUICK 

3 

904 

JOS 

S3 

3 

5."^, 

543 

54 



- 

=_  — 

Salo 

' 

I 

Contingent   LiaMUtit* 

InEuranct 

Omdeods 

71 

7«il 

Deprectatton 

Net  Prodj 

' 

Ootelde  Mcana 

Fig.  5. — Comparison  of  Statements — AU-American  Packing  Company 


26  WILSON  AND  CARPENTER 

II.    Analysis  of  a  Packing  Statement 

We  shall  now  take  up  tlie  statement  of  a  concern 
engaged  in  the  meat-packing  business.  The  methods 
used  in  financing  such  a  business  introduce  some  new 
points  in  statement  analysis. 

Figure  4  shows  the  form  in  which  the  figures  are 
received  from  the  company. 

For  the  sake  of  clearness  we  shall  show  the  company  ^s 
statement  as  compared  with  that  of  the  previous  year  on 
the  comparison  sheet,  Figure  5. 

The  point  that  stands  out  forcibly  is  the  indebtedness 
of  the  company.  However,  with  concerns  engaged  in 
this  line  of  business  a  liberal  indebtedness  is  not  unusual, 
which  fact  is  attributable  to  the  rapid  turnover  of  the 
business.  This  necessitates  a  very  active  employment 
of  working  capital,  and  because  of  this,  it  will  be  found 
that  packing  concerns  are  rather  steady  borrowers  of 
their  banks. 

This  heavy  debt,  however,  is  offset  by  the  liquid 
character  of  the  inventory.  The  products  are  staple  and 
in  such  constant  demand  that  one  would  have  compara- 
tively little  difficulty  in  disposing  of  merchandise  of  this 
character  in  the  event  of  liquidation. 

NOTES   and   accounts   RECEIVABLE 

In  the  foregoing  statement  the  Notes  and  Accounts 
Receivable  are  combined,  and  if  possible  this  item 
should  be  divided,  as  it  is  quite  important  to  learn  the 
amount  of  the  Notes  Receivable.  Packing  products  are 
sold  on  short  terms,  and  one  seldom  looks  for  a  large 
amount  of  Notes  Receivable;  therefore,  should  the  item 
appear  substantial,  a  word  in  explanation  from  the 
customer  would  be  in  order. 


FINANCIAL  STATEMENTS  27 

MEECHANDISE 

From  the  comparison  of  the  statements  it  will  be 
noted  that  the  merchandise  item  has  increased  substan- 
tially over  that  of  the  previous  year.  When  favorable 
conditions  are  obtaining  in  whatever  line  of  business 
may  be  under  consideration,  a  reasonable  increase  in  the 
merchandise  item  is  not  necessarily  viewed  with  alarm, 
but  this  feature  should  always  be  given  due  thought  and 
investigation,  as  the  increase  may  be  the  result  of  higher 
prices  rather  than  of  a  heavier  inventory,  which  higher 
values,  under  less  favorable  conditions,  might  be  subject 
to  fluctuations  and  be  the  direct  cause  of  serious  loss  in 
a  succeeding  period. 

With  the  packing  company  under  discussion,  however, 
the  increase  reflected  would  not  seem  inconsistent  with 
the  normal  progress  of  the  business;  further,  the  quick 
salability  of  the  product  should  be  borne  in  mind. 

eeaIj  estate,  buildings,  machinery,  and  fixtures 

As  compared  with  the  previous  year,  this  item  also 
shows  a  material  gain.  What  is  the  reason  for  this? 
Does  it  represent  a  revaluation  of  the  real  estate,  or  new 
additions  and  extensions,  etc.?  Are  further  building 
operations  contemplated  during  the  coming  year?  How 
are  they  to  be  financed,  and  what  depreciation  has  been 
made  on  the  property? 

notes  and  accounts  payable 

This  item  also  should  be  divided.  While  there  is  a 
marked  increase  in  the  account  over  that  of  the  pre- 
vious year,  this  can  be  attributed  to  the  carrying  of  a 
heavier  inventory. 


28  WILSON  AND  CARPENTER 


HENDKICKS  BKOTHERS 
SEATTLE,  WASH. 

December  31,  1916 
Assets 

Cash    $  16,728.29 

Merchandise   391,607.51 

Accounts  Receivable    437,400.03 

Notes  Receivable 12,163.17 

Machinery  &  Fixtures 37,420.01 

Investments    135,000.00 

$1,030,319.01 

Liabilities 

Notes  Payable   $  350,000.00 

Accounts  Payable   76,742.95 

Taxes,  Insurance,  etc 23,141.01 

Deposits  of  Partners  &  Friends 46,693.27 

Net  Worth    433,741.78 

Special  Capital 100,000.00 

$1,030,319.01 

Sales  $1,667,000.00 

Profits   92,543.00 

Withdrawals  40,000.00 

Notes  Receivable  discounted 
and  not  included  in  the 
above    35,545.00 

FlO.  6. — Hendricks  Brothers'  Statement 


FINANCIAL  STATEMENTS 


29 


COMPARISON   OP    STATEMBNTS 

JDI 

BEES'  BOOTS  A  SHOES 

ASSETS 

;^P      ^1       ^<i^f, 

1 

Ciih 

ifi 

7?fi 

Billi  RecririWc.  Cwtomtn 

1? 

^f\^ 

17 

4:17 

4np 

0:^ 

McKluixlMe.  finUhed 

n9i 

fi07 

51 

Merchvxiuc.  unfiDiibcd 

1 

Rio  M«i«ri*l 

TOTAL  QUICK  ASSETS 

657 

B9a 

00 

Rcat  Ettite 

BWo. 

Machintn-  St  Fixlurct 

?7 

420 

01 

patent*  tt  Paiierat 

R»il  f^ic.  Outiide 

l.'fi 

wo 

9a  p 

113 

J2i 

1                                                  TOTAL 

__ 

LIABILITIES 

nilU  Pavattir   to  nwn  Rjinkt 

?50 

000 

00 

_ 

7n 

74?, 

<)? 

[^p.    nf    Partn.»rs   A   Pr    rnti 

i  4'= 

f^?,' 

?7 

£2 

141 

ni 

TciTAt,  CynrqtT  LrABitiTiu 

4?f- 

."777 

?„1 

Mtrt.   on  R    E    (When  dtie) 

Tgul  Lwbiliiifi 

4''fl 

fi77 

?;" 

N«t   Wonh 

4W 

741 

7- 

Special  .CapinaL   ,  ..  ., 

\m 

QOO 

_C0| 

TOTAL 

y., 

fiiVl 

?IS 

ni 

j- 

TOTAL  QUICK  ASSETS 

9f)i^ 

P?3 

oc 

CirRRF,NTUABlLITlE5 

'^. 

496 

577 

KfCESS-OUIOC 

3W 

321 

77 

w«                                      1 

^6i 

090 

00 

CoDiinaeoi  L«>ibi!itr« 

il'i 

V^ 

Profit. 

92 

S4S 

00 

W'.r.hrtraiials 

40 

009 

00 

ft 

1 

Fig.  7. — Comparison  of  Statements — Hendricks  Brothers 


30  WILSON  AND  CARPENTER 

BONDED   DEBT 

In  this  instance  no  annual  retirement  has  been  stijDU- 
lated,  and  as  the  final  maturity  of  the  issue  is  still 
some  time  hence,  there  is  little  to  worry  about  on  that 
score ;  but  it  must  not  be  forgotten,  however,  that  there 
is  an  annual  interest  charge  of  $60,000  to  be  paid. 

GAIN   FOR   THE    YEAR 

"We  have  not  been  given  the  volume  or  profits  in  this 
case,  but  the  successful  year  enjoyed  by  the  company  is 
best  evidenced  by  the  fact  that  after  paying  the  regular 
7  per  cent  dividends,  the  Surplus  item  shows  an 
increase  of  some  $128,000. 

CONCLUSION 

A  view  of  the  statement  as  a  whole  shows  it  to  be  a 
very  satisfactory  one,  and  despite  tlie  increased  indebt- 
edness, the  figures  indicate  that  the  business  is  in  good 
liquid  condition  and  showing  progress. 

III.     Analysis  of  a  Jobbing  Statement 

The  next  statement  to  be  analyzed  is  that  of  a  jobbing 
concern  in  the  shoe  line.  The  statement  received  from 
the  firm  is  represented  in  Figure  6. 

This  is  not  a  particularly  attractive  statement.  For 
a  concern  engaged  in  this  line,  the  indebtedness  is  too 
heavy,  indicating  a  lack  of  working  capital,  which  is  also 
further  verified  by  the  practice  of  discounting  receiva- 
bles. 

notes   AND   ACCOUNTS   RECEIVABLE 

A  comparison  of  these  items  with  the  volume  indicates 
that  collections  are  not  being  watched  as  closely  as  is 


FINANCIAL  STATEMENTS  31 

necessary.  In  this  line  of  business  accounts  usually 
average  close  to  60  days,  but  with  this  firm  it  will  be 
noted  that  accounts  are  averaging  about  90  days. 

NET  WORTH 

In  comparing  statements  the  fluctuations  of  the  net 
worth,  as  in  the  case  of  the  surplus  item  in  corporations, 
should  be  carefully  watched,  and  an  explanation  should 
be  forthcoming  for  any  imusual  decline  in  this  item. 

It  will  be  noted  that  the  withdrawals  for  the  year 
amounted  to  $40,000,  and  in  view  of  the  lack  of  working 
capital  evidenced,  it  can  be  readily  appreciated  that  it 
would  have  been  better  to  have  allowed  this  money  to 
remain  in  the  business. 

SPECIAL   CAPITAL 

In  the  case  of  a  firm,  the  means  of  the  general  part- 
ners, both  in  and  out  of  the  business,  are  at  the  risk 
of  the  business  with  certain  exemptions  under  the  laws 
of  some  states,  such  as  homestead  laws,  etc.  This  is 
not  so  in  the  case  of  a  contributory  or  special  partner, 
whose  liability  extends  only  to  the  amount  of  his  invest- 
ment. 

Special  capital  is  usually  left  in  the  business  for  a 
definite  period  and,  therefore,  it  is  necessary  to  secure 
the  maturity  date,  as  the  necessity  of  paying  out  such 
an  interest  could  very  well  cripple  the  credit  standing. 

DISCOUNTED   RECEIVABLES 

At  the  foot  of  the  statement  it  will  be  noted  that  the 
company  has  discounted  with  its  banks,  receivables  to 
the  extent  of  $35,000.     This  is  one  of  the  unfavorable 


32  WILSON  AND  CARPENTER 

features  of  the  statement  and,  as  mentioned  above,  is 
indicative  of  the  lack  of  working  capital.  In  some 
instances  the  practice  of  discounting  receivables  is  fol- 
lowed in  order  to  facilitate  the  collection  of  the  notes. 
If,  therefore,  some  question  might  arise  in  the  mind  of 
the  credit  grantor  as  to  whether  the  receivables  had 
been  discounted  to  secure  immediate  use  of  the  funds,  or 
the  practice  had  been  followed  only  for  collection  pur- 
poses, this  point  could  be  covered  by  inquiry. 

IV.    Analysis  of  a  Cotton  Mill  Statement 

We  now  have  for  consideration  the  financial  statement 
of  a  cotton  mill.  Figure  8  is  the  form  in  which  the 
statement  is  received  from  the  mill. 

When  examining  the  financial  status  of  a  cotton  mill, 
the  features  to  be  borne  in  mind  are  the  size  of  the 
plant,  its  physical  character,  the  nature  of  the  product, 
and  the  ability  and  morale  of  the  management. 

CURRENT  assets 

The  output  of  cotton  mills  which  manufacture  staple 
lines,  such  as  gray  goods,  sheetings,  shirtings,  drills, 
ginghams,  etc.,  is  of  a  most  liquid  character.  The  raw 
cotton  on  hand  or  contracted  for,  could  always  be  sold  in 
the  open  market.  There  is  also  an  open  market  for  the 
finished  product,  and  the  merchandise  in  process  could 
with  great  rapidity  be  turned  into  the  finished  product 
and  readily  sold.  The  quick  liquidating  character  of  the 
inventory  is  therefore  readily  apparent. 

The  practice  of  disposing  of  the  output  through  sell- 
ing agents  of  established  financial  standing  and  with 
broad  distributing  facilities  is  another  element  of 
strength  inasmuch  as  it  eliminates  credit  risks  in  con- 


FINANCIAL  STATEMENTS  33 

nection  with  sales  and  the  expense  of  finding  a  market 
for  the  merchandise.  The  commisson  house  makes  fre- 
quent settlements  with  mills,  and  from  this  it  can  be 
seen  that  credits  with  selling  agents  or  commission 
houses  are  almost  as  available  as  cash  in  bank. 

FIXED   ASSETS 

The  fixed  assets  of  a  cotton  mill  have  more  definite 
liquidating  value  than  is  the  case  with  most  other  lines 
of  manufacturing.  The  equipment  and  processes  in  this 
industry  are  quite  standardized.  AMiile  skill  is  required 
to  conduct  the  business,  skilled  manual  labor  is  not  an 
important  factor.  Most  of  the  work  is  done  by  automatic 
machinery,  and  no  special  difficulties  are  presented  in 
establishing  or  maintaining  the  operating  end  of  the 
organization.  It  is  not  an  especially  complicated  busi- 
ness. 

Furthermore,  a  large  part  of  the  machinery  in  a  cot- 
ton mill  can  be  moved.  Second-hand  machinery  is  fre- 
quently purchased  and  moved  from  one  mill  to  another. 
It  has  a  tangible  value,  independent  of  the  plant  in 
w^hich  it  is  installed.  These  things  tend  to  make  a 
readier  market  for  the  sale  of  cotton  mills  and  their 
so-called  "fixed  assets."  Hence  the  plant  and  equip- 
ment has  some  more  or  less  defined  liquidating  value 
and  the  figures  set  up  in  the  statement  are  liable  to  less 
shrinkage  on  a  forced  sale  than  is  the  case  in  most  other 
kinds  of  manufacturing  plants.  Therefore,  the  fixed 
assets  play  a  more  important  part  than  usual  m  consid- 
ering the  commercial  credit  of  the  mill.  And  it  is  a 
corollary  that  the  ratio  of  quick  assets  to  indebtedness 
is  generally  smaller  than  in  other  commercial  risks.  It 
follows  then  that  the  fixed  assets  must  be  more  care- 
fully considered  than  in  a  risk  where  the   ratio   of 


34  WILSON  AND  CARPENTER 


ALLISON  COTTON  MILLS 

CHARLOTTE,  N.  C. 

December  31,  1916 

Assets 

Cash $  49,731.85 

Merchandise  Finished 17,868.02 

Merchandise  Unfinished   30,876.00 

Cotton   29,963.93 

Real  Estate,  Buildings,  etc 641,790.46 

Prepaid  Interest,  Insurance,  etc 28,133.06 

Due  from  Selling  Agency 187,768.14 

$986,131.46 

Liabilities 

Notes  Payable    $200,000.00 

Accounts  Payable  21,397.16 

Accrued  Wages,  Taxes,  etc 9,206.58 

Reserve  for   Depreciation 170,101.60 

Capital  Stock    350,000.00 

Surplus    235,426.12 


$986,131.46 


Fig.  8. — Statement  of  the  Allison  Cotton  Mills 


FINANCIAL  STATEMENTS 


35 


COMPARISON   OP  ST 

AUlSQlL5aTTOH.MILL5!»_    CH/JILOTTE.   If.    C. 

\T 

EEMBNTS 

„n-.»..J*;lWIPllVI1TB«>«f  StlEGf  n"l!*, 

Be  e/1. Direct 

^S5"*                   iDe...    31.    1916 

1 

- 

Cash 

« 

7.-<l 

3£ 

Bills  Receivable.   Customers 

Accounts    Receivable,    Customers 

Mcrcbacdise,  finished 

17 

J  fill 

)p 

Mercbandise,  anfiaished 

in 

17fi 

10 

Raw  Materi»l  OottQD                    1 

z° 

)63 

!3 

Due    from   Snllln^   Ar^nntc 

tfl7 

?(in 

11 

TOTAL  OUICK  \S5etS 

^\h 

TI7 

M 

Keal  tBlate                                     , 

( 

S41 

7<in 

\f\ 

Machioery  &  Fixtures 

Fatenli  &  Good  WUl 

Ins.,  etc. 

2B 

J.V 

)6 

r 

1 

TOTAL  1 

Iflp 

i?i 

Ifl 

— 

tiAtldxItk         1 

Bills   PaTable.    Mercbandise         t| 

■"" 

Bills   Payable  to  OWD  Banks        11 

?,m) 

pm 

in 

U.lls   I'ayable.  olherwise                )i 

Accounts  Pajrable 

21 

597 

16 

Chattel  Hortgages,  etc 

q 

RPfi 

sn 

T«Tat  Cmutirr  LiAiiunu 

?.in 

w^s 

^rt 

Bonded    Debt    (When    due) 

Mortgage  Loans  (When  due) 

Hes.  for  deoreolatlon 

170 

10,1 

iO 

Total  LiabUltttl 

W 

fOfi 

\i- 

■ -|-AMh:Wel        *(... 

^•'■-  I  Auti.  Cool. 

VV\ 

Km 

in 

Surplus  &   Uodivld£d   Pro&l« 

235 

126 

z 



TOTAL 

<n. 

>n7 

- 

- 

TOTAL    QUICK    ASSETS 

14 

-  CURRENT  LIABILITIEJ 

<> 

:.io 

.O,'? 

4 

EXCESS-QUICK 

£&. 

ifili 

sL 

Salca 

" 

Cootiii«ui1   UabUities 

lutumnM 

Diridends 

Depredation 

Net  Froaes 

\ 

Outside  Means 

1 

Fig.  9. — Comparison  of  Statements — Allison  Cotton  Mills 


36  WILSON  AND  CARPENTER 

quick  assets  is  higher  and  where  consequently  the  fixed 
assets  are  more  prone  to  be  disregarded  or  eliminated 
in  passing  the  commercial  credit. 


MANAGEMENT 

It  is  important  to  learn  the  history  of  the  manage- 
ment, its  record  for  successful  operation  over  a  period 
of  years,  its  freedom  from  speculative  tendencies,  its 
policy  with  respect  to  plant  extension,  and  its  moral 
standing.  The  purchase  of  raw  material  affords  many 
opportunities  for  speculation  necessitating  a  close  check 
on  this  feature  of  the  risk.  As  a  general  rule,  a  mill 
man  should  cover  his  orders  with  cotton  or  contracts 
with  cotton  merchants,  thereby  eliminating  the  hazards 
incident  to  the  fluctuations  in  the  price  of  cotton. 

With  the  mill  under  discussion  the  small  margin  of 
working  capital  will  be  noted;  but  if  one  considers  the 
fundamental  features  mentioned  in  the  foregoing  and  is 
satisfied  as  to  the  moral  character  and  ability  of  the 
management  and  the  earning  power  evidenced  by  the 
business  over  several  years,  the  risk  would  appear  sat- 
isfactory, as  one  could  be  assured  that  the  money  loaned 
could  be  quickly  turned  into  merchandise,  sold  and  con- 
verted into  cash,  and  the  indebtedness  liciuidated. 

V.     Summary 

The  foregoing  analj^sis  of  statements  from  various 
industrial  lines  emphasizes  some  of  the  vital  points 
involved  in  the  analysis  of  fmancial  statements.  It  is 
obvious  that  an  efficient  knowledge  of  the  principles  of 
accounting  is  required  to  appreciate  the  accounting 
significance  of  each  item,  but  in  the  final  interpretation 


FINANCIAL  STATEMENTS  37 

of  a  statement,  a  still  broader  knowledge  is  required, 
involving  these  five  general  points : 

1.  Line  of  business. 

2.  Terms  of  purcliase  and  sale. 

3.  Local  conditions,  geographical  or  otherwise. 

4.  Necessary  capital  for  needs  of  business. 

5.  Ability  and  character  of  the  management. 

The  underlying  principle  of  the  proper  analysis  of  the 
financial  statement  is  this:  Determine  those  items 
Avhich  in  the  usual  course  of  business  would  indicate  the 
debt-paying  or  liquidating  ability  of  the  concern  under 
consideration. 


SELF-TEST  QUESTIONS 

These  questions  are  for  the  reader  to  use  in  testing 
his  knowledge  of  the  treatise.  The  answers  are  not  to 
be  sent  in  to  the  university. 

1.  What  groups  of  business  men  are  particularly  interested 
in  the  analj'sis  of  financial  statements? 

2.  TIov/  may  the  analysis  of  a  credit  man  differ  from  that 
of  an  investor? 

3.  What  are  the  principal  special  characteristics  of  the 
wholesale  grocery  business  that  have  a  bearing  on  credit 
analysis  ? 

4.  How  is  the  ratio  of  "quicks"  determined  in  credit 
analysis  ? 

5.  What  is  the  function  of  the  "Comparison  of  State- 
ments"? 

6.  Explain  at  least  three  factors  to  look  out  for  in  the 
examination  of  the  cash  item. 

7.  Why  should  the  Notes  Receivable  item  be  relatively 
small  in  a  wholesale  grocery  statement? 


38  WILSON  AND  CARPENTER 

8.  What  effect  does  the  use  of  acceptances  have  upon  the 
figures  of  the  statement? 

9.  Explain  by  illustration  how  to  figure  the  period  which 
collections  average. 

10.  Indicate    at   least   four    important   tests    to    apply   to 
Accounts  Receivable. 

11.  What  points   should   be    checked   in   the   merchandise 
item? 

12.  How  may  investments  affect  the  debt-paying  ability  of 
a  concern? 

13.  How  should  consignment  accounts  be  regarded? 

14.  Explain  how  to  check  Notes  Payable. 

15.  How  should  reserves  be  treated? 

16.  How  would  you  check  up  bonded  debt? 

17.  How  is  net  worth  determined? 

18.  What  information  does  a  Profit  and  Loss  Statement 
supply  ? 

19.  What  comparisons  with  previous  statements  might  be 
made? 

20.  In   what    different   ways   may    a    contingent    liability 
arise  ? 

21.  What    special    points    are    to    be    considered    in    the 
analysis  of  a  packing-house  statement? 

22.  What  special  considerations  may  be  given  to  the  cur- 
rent assets  of  a  cotton  mill?    To  the  fixed  assets? 

23.  Is  a  large  working  capital  essential  in  a  cotton  mill? 
Why? 

24.  What    are    the    principal    points    to    consider    in    the 
analysis  of  financial  statements  as  brought  out  in  this  treatise  ? 


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FEB  4    1959 

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LD  'Jl-SOm-S.S'J 


!  GAYLAMOUNT 

PAMPHLET  BINDEt 

ManafaclurtJ  by 

I  eAYLORD  BROS.  U*.  \ 

Syracuse,  N.  Y. 

Stockton,  Calif. 


401592 


UNIVERSITY  OF  CALIFORNIA  LIBRARY 


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